German 10-year bund yields are at the brink of turning negative, ending the week at a record low 0.02%. Italian 10-year spreads (to bunds) widened 10 bps this week to a four-month high 136 bps. UK 10-year yields closed Friday at a record low 1.23%. Japanese yields ended the week at a record low negative 0.17%. Treasury yields closed Friday at a three-year low 1.64%.

June 10 - CNBC: "A new poll showing a majority of British people in favor of leaving the European Union hit foreign Exchange and stock markets on Friday. The data in London newspaper The Independent showed that 55 percent believe Britain should leave the EU, versus 45 percent who favored staying. The publication said it marked the largest portion of respondents who favored exiting since research firm ORB began polling the issue for it last year." The British pound dropped 1.39% Friday on polls showing Brexit with a widening lead.

Currency markets remain unsettled. The pound dropped 1.8% this week, with the Swedish krona down 2.1%, the Norwegian krone 1.2% and the euro 1.0%. Meanwhile, the Brazilian real surged 3.1%.

I can imagine the sense of excitement readers have to dive into the details of the latest Z.1 report. Watching paint dry and grass grow… Even for me, the Fed’s Q1 “flow of funds” data was for the most part uninspiring. At this point, Credit is growing adequately. “Money” is expanding briskly. The vulnerable corporate debt sector came to life during Q1. The banks are “dancing,” with bank Credit now in the strongest expansion since before the crisis.

Importantly, securities market values are new all-time highs, with Household Net Worth inflating to record levels. Yet there’s a strong case to be made of latent fragilities – system vulnerability to a reversal in bond, stock and real estate prices.

Non-Financial Debt (NFD) expanded at a 4.8% rate during Q1, down from Q4’s (distorted) 8.8% but up from Q3’s 2.2%. Total Household debt growth slowed to 2.7% annualized, down from Q4’s 3.7%. Household mortgage debt was unchanged from Q4 at a 1.6% pace, while growth in Consumer Credit was unchanged at 6.1%. Corporate debt growth bounced back strongly. Corporate Credit growth had slowed meaningfully, from 2015’s Q1’s 9.1% to Q2’s 8.7% to Q3’s 4.8% and then to 2.9% in Q4. The first quarter saw Corporate Credit growth surge to an 8.9% pace. State & Local borrowings accelerated marginally to 2.2%. After the federal government’s blistering 18.5% fourth quarter borrowing pace, debt growth slowed to 4.6% in Q1.

It’s often helpful to view the data in seasonally-adjusted and annualized rate (SAAR) terms.

Breaking down SAAR debt growth for the quarter, Total Household Borrowings increased SAAR $379bn (mortgage $156bn and consumer $214bn), Total Business SAAR $1.014 TN, State & Local SAAR $66bn and Federal SAAR $700bn. It’s worth noting that Business borrowings over the past year have been at the strongest pace since record 2007 borrowings.

Led by ongoing strong Treasury issuance, total Debt Securities (the Fed’s accumulation) expanded $526 billion during the quarter to a record $40.218 TN. As a percentage of GDP, Debt Securities increased to 221%. Debt Securities began the eighties at 74% of GDP, the nineties at 126% and the new Millennium at 162%. Total Equities declined marginally during the first quarter to $35.496 TN, or 195% of GDP. Equity Securities began the eighties at 44% of GDP, the nineties at 67% and ended 1999 at 201%. Total Securities (Debt and Equities) ended Q1 at $76.618 TN, or 420% of GDP. Total Securities began the eighties at 117% of GDP, the nineties at 193% and the new Millennium at 362%.

Buoyed by near-record securities market values, the bloated Household Balance Sheet remains a primary Bubble Economy variable. Household Assets increased another $855bn during Q1 to a record $102.6 TN. And with Liabilities up only $18 billion during the quarter, Household Net Worth (HNW) jumped $83.7 billion to a record $88.1 TN. HNW ended 2007 at $66.7 TN, and then fell below $49.0 TN in early 2009. HNW-to-GDP ended the first quarter at 483%, compared to 446% and 461% to end Bubble Years 1999 and 2007. Household holdings of Financial Assets increased $300 billion to a record $71.1 TN (390% of GDP). Inflating home prices saw Real Estate holdings jump almost $500 billion during the quarter to a record $25.8 TN. Household Net Worth has now inflated 81% from Q1 2009 lows.

On the bank (“Private Depository Institutions”) Liability side, Deposits are expanding rapidly. Total Deposits expanded nominal $252 billion during the quarter, or 7.8% annualized. Deposits have inflated $3.589 TN, or 37%, in just over five years to $13.215 TN.

During the quarter, bank lending picked of the slack as other sectors slowed markedly. The GSE’s contracted SAAR $88 billion, reversing some of Q4’s strong expansion (SAAR $298bn).

It’s my view that significant amounts of speculative finance continue to gravitate from the faltering global “periphery” to the perceived stable “core” U.S. securities and asset markets.Z.1 data have not necessarily supported this analysis in recent quarters. After two consecutive quarters of net liquidation, Rest of World (ROW) “Net Acquisition of Financial Assets” increased $667 billion during Q1. Holdings of U.S. Corporate Bonds increased SAAR $178 billion, after Q4’s SAAR $364 billion gain. ROW now holds $3.075 TN of U.S. corporate bonds, $6.285 TN of Treasuries, $5.564 TN of U.S. equities, $2.064 TN of short-term deposits/money funds/repos, and $3.659 TN of direct investment. After beginning the new Millennium at $5.621 TN, ROW holdings of U.S. assets has inflated to a staggering $23.104 TN.

June 10 – Financial Times (Mehreen Khan): “A small change in central bank interest rates risks triggering an abrupt reversal in global markets, in echoes of the last financial crisis, the head of the German Bundesbank has warned. In his latest warning on the unwanted side effects of persistently low interest rates, Jens Weidmann said investors and asset managers could become ‘increasingly nervous’ in a world stuck with near negative rates as it raised the possibility ‘of a sudden hike in risk premiums’. He said monetary policymakers’ attempts to issue forward guidance hinting that rates will stay lower for longer, and lengthy aggressive bond-buying, had ignored consequences for financial stability…”Credit Bubbles survive only so long as ample new Credit is forthcoming. Asset Bubbles persevere only so long as new “money” flows readily into the asset class and prices continue to inflate. I have argued that the current Bubble is deeply systemic, impacting virtually all asset classes. Undoubtedly, however, the most spectacular Bubble excesses continue to unfold throughout global bonds and fixed-income. I can appreciate Bill Gross discussing a $10 TN “supernova” that’s going to explode catastrophically “one day”. I can also respect legendary speculator George Soros’ decision to return to active trading with a host of bearish views and bets he expects to pay off one day soon. Gross and Soros are examining the same world as we are and must be in similar utter disbelief at what has transpired. Things turn notoriously Crazy near the end. We have witnessed Historic Crazy.

It’s a Good Thing the Fed Has Missed its Chance to Raise Rates. Here’s Why.

The Fed's main mission is low inflation and high employment, not boosting interest rates

By Greg Ip

Photo: Andrew Harnik/Associated Press

A shockingly weak May jobs​ report​ knocked the Federal Reserve off what looked like a clear course to raise interest rates in the next few months. Up and down Wall Street, you could hear the groans: once again the Fed missed its chance.​For two years now the Fed has charted a path to steadily raise interest rates, but has regularly pulled back because the economy suddenly weakened, inflation dropped, or the financial markets acted up. The Fed still thinks rates will gradually rise as unemployment falls, which leaves it “looking for windows of opportunity to raise rates​,” as my colleague Jon Hilsenrath puts it.​ ​Critics say it has boxed itself in: By simply preparing to raise rates, the Fed triggers conditions that make it impossible to follow through.Yet this logic has perverse implications. It says the Fed tightens when it can, not when it should. This confuses the tool of monetary policy, interest rates, with​ its goal, which is low unemployment and stable inflation around 2%.The Fed’s rate target was near zero from 2008 to 2015 and, after just one increase, sits between 0.25% and 0.5%. So isn’t it self-evident that rates have to rise? Isn’t that what the Fed believes, with its dot plots tracing out a steadily rising path for the Fed funds target?Actually, no: The right level of rates will have been achieved when the economy is at full employment and inflation at 2%. A few years ago officials thought that magic interest rate (they prefer the term “neutral” or “equilibrium rate”) was 4%. Now they think it’s 3.3%. In her speech Monday, Janet Yellen, the Fed chairwoman, suggested it may now be less than 2%. These are all guesses. For all they know the right number is 0.25%. No economic law dictates what Fed funds rate should correspond to a fully employed economy.To say the Fed missed its chance is to argue that rates today should already be higher. But if they were, then the slowdown (if indeed there is one) now underway would have come sooner.Wouldn’t higher rates, though, have given the Fed more ammunition to deal with such a slowdown? Yes, but that would be a ​P​yrrhic victory. It means the economy’s starting point would have been feebler, with unemployment at, say, 6% instead of near 5%. That interest-rate ammunition would have been purchased at a steep price in terms of foregone jobs and incomes.There are two reasons why the Fed might wish it had raised rates sooner. One is that inflation quickly rises past its 2% target, requiring a much more dramatic tightening and possibly recession to get it back. That looks exceedingly unlikely. In fact, long-term inflation expectations, already below 2%, are dropping further.The other is that the prolonged period of zero interest rates feeds destabilizing financial speculation, which eventually ​reverses, violently, leaving the economy worse off than if the Fed had tamped ​things ​down sooner.This second concern is not a trivial risk. The right response is for the Fed to weigh the benefits of keeping rates low, which are higher employment now, against the costs, which is a slightly higher probability of a large loss of employment later. In 2014 that tradeoff may have favored moving as markets were quite frothy. Since then, the mere expectation of tightening has cooled risk-taking, and that is probably why the economy, with a lag, has slowed​.Ms. Yellen indicated that notwithstanding May’s lousy jobs numbers, she still thinks the labor market will get stronger. She’s probably right. On the other hand, according to J.P. Morgan, the odds of recession in the coming year have risen to an uncomfortably high 36%. If in fact a recession comes to pass, one thing​ is certain​: The Fed will be glad it didn’t tighten even more.

CAMBRIDGE – However November’s presidential election in the United States turns out, one proposal that will likely live on is the introduction of a financial transaction tax (FTT). While by no means a crazy idea, an FTT is hardly the panacea that its hard-left advocates hold it out to be. It is certainly a poor substitute for deeper tax reform aimed at making the system simpler, more transparent, and more progressive.

As American society ages and domestic inequality worsens, and assuming that interest rates on the national debt eventually rise, taxes will need to go up, urgently on the wealthy but some day on the middle class. There is no magic wand, and the politically expedient idea of a “Robin Hood” tax on trading is being badly oversold.

True, a number of advanced countries already use FTTs of one sort or another. The United Kingdom has had a “stamp tax” on stock sales for centuries, and the US had one from 1914 to 1964. The European Union has a controversial plan on the drawing boards that would tax a much broader array of transactions.

The presidential campaign of US Senator Bernie Sanders, which dominates the intellectual debate in the Democratic Party, has argued for a broad-based tax covering stocks, bonds, and derivatives (which include a vast array of more complex instruments such as options and swaps). The claim is that such a tax will help repress the forces that led to the financial crisis, raise a surreal amount of revenue to pay for progressive causes, and barely impact middle-class taxpayers.

So far, Hillary Clinton, the likely Democratic nominee, has embraced a narrower version that would target mainly high-speed traders, who account for a large percentage of all stock transactions, and whose contribution to social welfare is open to question. Clinton, however, may well shift closer to Sanders’s position over time, as she has on other issues. Donald Trump, the presumptive Republican nominee, has not yet articulated a coherent position on the topic, but his views often come down remarkably close to those of Sanders.

The idea of taxing financial transactions dates back to John Maynard Keynes in the 1930s and was taken up by Yale professor and Nobel laureate James Tobin (who, incidentally, was my undergraduate professor) in the 1970s. The idea, in Tobin’s words, was to “throw sand in the wheels” of financial markets to slow them down and make them hew more closely to economic fundamentals.

Unfortunately, this rationale has not held up particularly well either in theory or in practice. Particularly misguided is the idea that FTTs would have significantly muted the buildup to the 2008 financial crisis. Centuries of experience with financial crises, including in countries with FTTs, strongly suggests otherwise.

What is really needed is better regulation of financial markets. The unwieldy and deeply imperfect 2010 Dodd Frank legislation, with its thousands of pages of provisions, is a stopgap measure; few serious people view it as a long-term solution. A far better idea is to force financial firms to issue much more equity (stock), as Stanford University’s Anat Admati has proposed.

The more banks are forced to evaluate risks based on shareholder losses rather than government bailouts, the safer the system will be. (On this score, Boston University professor Laurence Kotlikoff’s more radical ideas for taking leverage out of the financial system merit serious attention, even if his own quixotic presidential campaign otherwise goes unnoticed).

The fundamental problem with FTTs is that they are distortionary; for example, by driving down stock prices, they make raising capital more expensive for firms. In the long run, this lowers labor productivity and wage levels. True, all taxes are distorting, and the government has to raise money somehow. Yet economists view FTTs as particularly troublesome because they distort intermediate activity, which amplifies their effects. A modest tax that is narrowly targeted, like the UK’s, does not seem to cause much harm; but the revenue is modest.

To get more revenue requires casting the net much wider. For this reason, the Sanders plan covers derivative instruments that would circumvent the FTT (for example, by allowing people to trade income streams on assets without trading ownership). But extending the tax to derivatives is a messy business, because their complexities make it difficult to define precisely what should be taxed. And as the impact of the tax expands, it becomes hard to know what the ultimate effects on the real economy will be.

It is certainly difficult to determine whether the outsize revenue estimates of the Sanders campaign could be realized; many studies suggest otherwise. The claim is that the US can collect more than five times the amount the UK collects on its narrow tax – an amount equal to more than 10% of revenue from personal income tax. The problem is that trading will likely collapse in many areas, and many financial trades will be executed in other countries. If economic growth is affected, eventually other tax revenues will fall, and if government bonds are covered, borrowing costs will rise.

The US desperately needs comprehensive tax reform, ideally a progressive tax on consumption. In any case, a properly designed FTT can be no more than a small part of a much larger strategy, whether for reforming the tax system or for regulating financial markets.

SPIEGEL speaks with NATO Secretary General Jens Stoltenberg about the alliance's response to Russian aggression, the growth of member state defense spending and whether Turkey still shares the organization's values. SPIEGEL: Mr. Secretary General, three former high-ranking NATO generals have sharply criticized the alliance's Russia policy. They wrote that NATO has "too often acted like a homeowner who sets the alarm once the burglars have left." What is your answer to that criticism?Stoltenberg: NATO is the most successful alliance in history. Thus far, we have prevented war through a combination of strong defense and deterrence. Now we are positioning ourselves to address the challenge presented by an increasingly confident Russia. We have enhanced our presence in the eastern part of the alliance to a greater degree than any time since the Cold War and sent a strong message to potential adversaries.SPIEGEL: This enhancement is exactly what the generals are criticizing. They say it isn't credible because NATO has sent too few soldiers to the Baltic States and that Russia is in a position to block or impede reinforcements any time it wants.Stoltenberg: Our exercises have demonstrated the opposite to be true. We have just successfully completed the Brilliant Jump maneuver and transferred a Spanish brigade to Poland where it participated in a mission with units from Germany, Great Britain and many other countries.SPIEGEL: Maneuvers are one thing, but reality is often quite another. Estonian Prime Minister Taavi Roivas has demanded that NATO troops be permanently stationed in his country.Stoltenberg: We have developed detailed plans combining several elements for the defense of our Eastern European partners. At the NATO summit at the beginning of July in Warsaw, we will determine how to credibly defend ourselves in the future as well. Our planning staff has proposed sending battalion-sized units to various countries in the eastern part of the alliance which could be quickly reinforced in an emergency. We will improve our infrastructure and position materiel and reinforcements in the region. We have already opened eight small headquarters in the eastern part of the alliance area and the NATO rapid reaction force has been tripled in size, to 40,000 troops.SPIEGEL: NATO has been careful about sending more troops into its eastern member states because it wants to remain in compliance with the NATO-Russia Founding Act on Mutual Relations. When it signed this agreement, NATO wanted to create a new foundation for the relationship between Russia and the West. Will that agreement be sacrosanct forever?Stoltenberg: We comply with our international obligations and with the NATO Russia Founding Act. Our stronger presence in the east in the form of rotating troops, combined with the ability to bring in reinforcements in the case of a serious incident, is the right, balanced mixture and is in keeping with the counsel of our military planners. We can deploy NATO soldiers from Germany, Spain or Norway all over the world on extremely short notice, including to the Baltics. And don't forget one thing: We are no longer in the Cold War. Back then, there were hundreds of thousands of soldiers permanently stationed at NATO's borders. Today, the decisive factor is rapid deployability.SPIEGEL: Are we understanding you correctly: The NATO-Russia Founding Act will not be touched?Stoltenberg: It specifies that there will be no stationing of substantial combat units in the eastern areas of the alliance. Our plans are below this threshold in every way, regardless how one interprets this agreement.SPIEGEL: And if the security situation changes?Stoltenberg: As Secretary General of NATO, there is a limit to the number of hypothetical questions that one can answer. Anything else creates confusion. But I would like to say one more thing on the subject of Russia.SPIEGEL: Please.Stoltenberg: Our answer to the new security situation, precipitated by a more aggressive Russia, is defensive and it is proportionate. We have made it clear that we do not want any confrontations. We don't want a new Cold War. We are working to establish a more constructive relationship with Moscow.SPIEGEL: How do you intend to establish one?Stoltenberg: By continuing to seek a dialogue with Russia, and to strive for more transparency and predictability. The danger of an incident taking place has grown with the increased Russian military presence on our borders. Just take, for example, the Russian fighter jet that was shot down at the Turkish border or the risky flight maneuvers by Russian warplanes over the Baltic Sea. We should try to prevent these kinds of incidents if possible and when they do take place, make sure that they don't spin out of control.SPIEGEL: The alliance faces the challenge of having 28 member states that need to agree. In Russia, only one person makes the decisions: Vladimir Putin.Stoltenberg: When it's necessary, we can also make decisions very quickly. Think about our mission in the Aegean, which the Germans pushed for. We made the decision in a few days and our ships were on site within 48 hours. It is a strength, not a weakness, that NATO is an alliance of 28 open, transparent and democratic societies. History shows that democracies have forged the strongest military alliance that has ever existed.SPIEGEL: Polls show that 60 percent of Germans don't want to risk a war with Russia in order to defend other NATO partners like the Baltic States. Is public opinion in Germany a problem for NATO?Stoltenberg: People have different views in democracies. For me, as NATO secretary general, it is important that the alliance has shown that it makes decisions that can then be implemented.SPIEGEL: Independently of what the people think?Stoltenberg: In democracies, of course, you are dependent on the support of the citizens, because parliaments and governments need to be elected. But if you look at the past seven decades, we were always able to adapt to new challenges, and that is a product of democratic decision-making.SPIEGEL: We agree that Putin's autocracy shouldn't be a role model. But militarily, he has repeatedly been able to take the West by surprise in the past few years.Stoltenberg: In the end, democratic societies are stronger and more resilient than any autocracy. And more adaptable too. We have reacted to the changed security situation very quickly, after all, and our collective defense efforts have become more robust. That is a fundamental change.SPIEGEL: For years, NATO member states have repeatedly pledged to invest 2 percent of their gross domestic products into their defense budgets. But they aren't following through.Stoltenberg: There too we are seeing a shift. Last year, the trend of shrinking defense spending came to a halt after many long years. The forecasts for 2016 indicate that we will once again see increased defense spending among European NATO allies for the first time. The situation is still mixed, but things are improving.SPIEGEL: It isn't just Russian troops that are seen as a threat, primarily by Eastern European allies. Western intelligence services also believe that Moscow is behind some cyber-attacks. Has NATO underestimated this threat?Stoltenberg: No, we have strengthened our capabilities in order to protect our own NATO networks. We have also strengthened collaboration among allies, because they must first protect their own networks. We have established teams of experts that can help member states when they are attacked. And we have made a very important decision: A cyber-attack can be considered an armed attack according to Article 5 of the North Atlantic Treaty and thus trigger the collective defense clause.SPIEGEL: What response does the alliance have to the information war that Moscow is leading against the West?Stoltenberg: We are, indeed, registering a lot of propaganda, but our reaction to propaganda cannot also be propaganda.SPIEGEL: What then?Stoltenberg: The truth. In the end it will prevail. I am 100 percent convinced that an open society like that of Germany will ultimately be able to push facts through against the propaganda. It may be that opinion polls show a mixed picture, but at the same time, approval for NATO is growing. It means we must be doing something right.SPIEGEL: You have pointed out several times that NATO is an alliance of 28 democracies. One important member state is Turkey. Does it fit into the picture?Stoltenberg: NATO is based on shared values. Democracy, individual civil liberties and the rule of law. In public and also in meetings with the allies, I have repeatedly pointed out how crucial these common values are. They are the basis for our unity, and unity is the most important basis for our strength.SPIEGEL: Does the Erdogan regime in Turkey fulfill these requirements?Stoltenberg: These values are fundamental to NATO, and they are also very important for me. And in various meetings with the allies, I repeatedly point to them.SPIEGEL: That is an extremely diplomatic answer.Stoltenberg: (laughs) In my position, I also see myself as a diplomat.SPIEGEL: You have promised predictability and transparency. Those are two things don't seem to be very important to your NATO ally, Turkey.Stoltenberg:They apply to all allies, and Turkey is part of our effort to improve our diplomatic dialogue with Russia.SPIEGEL: Russia's intervention in Syria clearly took the West by surprise. Did NATO underestimate Moscow's military capabilities?Stoltenberg: We are living in a world in which developments are harder to predict and one that has become more uncertain. In such a world, you must be prepared for the unpredictable. Nobody predicted the fall of the Berlin Wall or the Arab Spring.SPIEGEL: What does that mean for NATO?Stoltenberg: That we need new capabilities. Enhancing our armed forces, more reconnaissance, more surveillance. We will soon be stationing new, state-of-the-art surveillance drones in Sicily.SPIEGEL: In order to monitor the streams of refugees from Libya?Stoltenberg: That depends on where the drones will be needed. When it comes to Libya: We have offered the new government help if it wants it. I've spoken with the Libyan prime minister. He wants to send a team of experts to Brussels and then we will see how Libya can be helped.SPIEGEL: Is that NATO's new line? No more deployments of its own, only helping other countries?Stoltenberg: We must also be in a position to make troops available in the future, as we did in the Balkans and Afghanistan. But at the same time, the focus will increasingly be on putting local troops in a position to ensure stability in their countries. We are working together with Iraq to train Iraqi troops in the fight against terror. In Afghanistan we have ended our combat deployment after 12 years, but we still have 12,000 NATO soldiers stationed there. Now we are tasked with helping the Afghans ensure their own security. In the long term, that makes more sense.SPIEGEL: Mr. Secretary General, thank you for this interview.

IN EAST ASIA, relations between China and America make the strategic weather. “When they are stable, the region is calm; when they are roiled, the region is uneasy,” noted Bilahari Kausikan, a Singaporean diplomat, in a recent lecture. In truth, ever since Richard Nixon went to China in 1972 and opened the modern era in Sino-American relations, the sky has rarely been entirely clear; but nor has it often been clouded by so many disparate disagreements as now. As the two countries’ bureaucrats from a range of ministries gather in Beijing on June 5th for their eighth annual mass date, the “Strategic and Economic Dialogue” (S&ED), rivalry is trumping co-operation. The best that can be expected this year is that the dialogue helps stem a slide into something more dangerous.An implicit challenge by China to the American-led world order has become explicit, as will be apparent at this year’s Shangri-La Dialogue, an annual high-level powwow on regional security to be held in Singapore from June 3rd to 5th. The venue China has chosen for this contest is the South China Sea, where its territorial claims overlap with those of Brunei, Malaysia, the Philippines and Vietnam (and are mirrored by those of Taiwan). That is where it has been throwing its weight around most alarmingly. China’s building over the past three years of artificial islands on some much-disputed rocks and reefs has perturbed the littoral states and exposed the hollowness of America’s naval predominance. American might has not deterred the construction spree; and it is hard to see how, short of full-blown war, the new islands will ever be either dismantled or snatched from Chinese control. America and China accuse each other of “militarising” the sea. Having insisted its island-building in the Spratly archipelago was for purely civilian purposes, the Chinese defence ministry used a row last month over its fighter-jets’ dangerous buzzing of an American reconnaissance plane to argue for “the total correctness and utter necessity of China’s construction of defensive facilities on the relevant islands”.In fact, despite sending warships on “freedom-of-navigation operations” near Chinese-claimed features, and having an aircraft-carrier group on patrol in the sea, America seems to be trying very hard not to provoke China too much. China is also anxious to avoid conflict. The prime concern of the ruling Communist Party is to retain power. As a way of losing it, fighting a war with America might be the most certain as well as the most catastrophic. Yet, at a time of slowing economic growth, the party increasingly relies on its appeal to Chinese nationalism. In this sense, as Mr Kausikan noted elsewhere in his lectures, “the very insignificance of the territories in dispute in the South China Sea may well be part of their attraction to Beijing.” Nobody expects America to go to war over a Spratly.What alarms America is that Chinese behaviour in the South China Sea seems to fit a pattern. In a speech on May 27th Ash Carter, the defence secretary, made a point belaboured by American leaders: that “On the seas, in cyberspace, in the global economy and elsewhere, China has benefited from the principles and systems that others have worked to establish and uphold, including us.” What, Americans wonder, is China’s problem? No country has gained more from the current order. Yet now, said Mr Carter, “China sometimes plays by its own rules, undercutting those principles.” The result: a “Great Wall of self-isolation”. Chinese analysts counter that America, too, plays by its own rules. A foreign-ministry spokeswoman accused Mr Carter of being stuck in “the cold-war era”, and implied his officials were typecasting China as a Hollywood villain.Indeed, as Mr Carter suggested, it is not just in its maritime adventurism that China is at odds with America. Old differences widen, as new ones crop up. It is hard for American leaders to ignore human-rights lobbyists, at a time when China is conducting one of its harshest crackdowns on dissent in recent years. Nor is American business brimming with enthusiasm for China. Rather, it grumbles about cyber-espionage, the theft of intellectual property, the stalling of negotiations on a bilateral investment treaty and a general perception that the trajectory of economic policy in China is no longer towards gradually increasing openness, but towards greater autarky and protectionism. It does not help that massive Chinese overcapacity in industries such as steel is generating trade disputes and fuelling anti-Chinese tirades in America’s election campaign.It used to be argued that, despite manifold areas of tension between China and America, the relationship was so complex and multilayered there would always be mitigating areas of mutual benefit. One of the reasons why relations are so fraught now is that such bright spots are so few. Most hopeful are shared commitments to move to cleaner energy and limit carbon emissions. Last year’s S&ED saw a “breakthrough”, on curtailing the ivory trade to protect elephants. The two countries are also co-operating for now in trying to curb North Korea’s nuclear ambitions. But the suspicion lingers that China worries more about the enforcement of sanctions that might topple the odious regime in Pyongyang than about North Korea’s weapons of mass destruction.

One no-trump

A final reason for scepticism about the S&ED’s prospects is the leadership politics of the two countries. It is a forum for bureaucrats. But China’s have to some extent been sidelined under the presidency of Xi Jinping, who has grabbed power for small party groups that he heads. So, in Beijing, the Americans may be talking to the wrong people. And, on their own side, Barack Obama’s presidency is ending. China may have taken his cautious foreign policy into account in pushing its claims in the South China Sea. It doubtless suspects that under either Donald Trump or Hillary Clinton, America is likely to be less of a pushover.

1. Market UpdateWe finally got the first dip in gold. Last week was an excellent chance to buy according to my mantra "buy the dip between $1,215 and $1,180". Unfortunately our limit for silver was missed by just $0.02. As well our limit for UGLD was not reached. But we were very lucky with Endeavour Silver.I hope you followed my recommendation to buy with a limit of $2.90. We got in right at the bottom and are up already 20%.Gold's underlying strength is obvious. We are very likely in a new bull market. Last week's low could have already been the summer low. I am not sure about that. We simply continue to buy low and sell high. But looking ahead towards the next couple of weeks we might be in for some serious liquidity crisis and turmoil with crazy volatility and falling prices in all asset classes. Why, because we're facing various potential shock events. The FED might raise interest rates, the British might vote for the Brexit, Spain might face a massive political shift in the coming election and the european football championship in France could see some nasty terror attacks. The outcome of all these events is very uncertain and each one could bring short-term havoc into the markets. Therefore I recommend to keep as much liquidity as possible. Stay out of bonds and stocks. If we're lucky our limits will get filled in a final panic sell off in the precious metals sector. Otherwise we're already well positioned for the next leg up and will buy more once the dust has settled.Regarding bitcoin the expected breakout has finally happened. Bitcoin is exploding and we're up 53%! The cryptocurrencies are getting more and more exciting and gaining traction all over the world. Let your winnings run!

2. Bitcoin - finally the massive long expected breakout

Since the top in early November at $500 Bitcoin has been in a large consolidation. I have often written about this rising triangle formation and the massive potential. Now the breakout has finally happened and the price for one bitcoin surged fast and furious to nearly $600. Our position is nicely up and we just have to let our winnings run. Of course, bitcoin is short-term overbought and it is not wise to chase the cryptocurrency here. We might get a pullback in the next couple of weeks or months which could lead to a test of the breakout level around $480-$500. Should we get such a pullback you should add to your positions or start buying bitcoins for the first time.

Last Friday gold finally did bounce as expected two weeks ago. Within 7 minutes gold jumped from $1,212 to $1,237. The massive move shifted my Gold Model from bearish to bullish.

Compared to my last public report two weeks ago we have one new bearish signal:Gold in $, €, £, ¥Seven elements shifted to bullish:

Gold in USD - Weekly Chart Gold Volatility - CBOE Index Gold in Indian Rupee Gold in Chinese Yuan GDX Goldminers - Daily Chart US-Dollar - Daily Chart US Real Interest RateIt will likely need a move back below $1,200 to switch the model to a bearish summary. Otherwise the bulls now have lots of signals in favor for them and might be able to push gold at least towards $1,262.

4. Gold - final sell off, prolonged consolidation or new up-cycle?

Gold has been falling from $1,303 down to $1,200 recently. For many weeks I've recommended to buy the dip into $1,215 - $1,180. So last week you had your chance. I am personally still not convinced that gold is ready for the next leg up but it is acting very strong and continues to hold above $1,200. My model has turned bullish and usually the model is right and I am wrong.. ;-) So here are the potential scenarios:

More sideways consolidation above/around $1,200 over the next couple of weeks until 200MA ($1,266) is hitting $1,200. That might take some more time.

Final sell off down towards the rising 200MA ($1,166) which would get everybody panicking and would create an outstanding entry chance.

The lows are already in and once gold takes out $1,262 the next target around $1,345 will be approached rather quickly.

Let's see how the market behaves. As you know we have to buy low so I am not chasing gold here but remain patient. We had a great chance last week already.Action to take: Wait until you can buy the VelocityShares 3xLong ETN (UGLD) below $10.00

Stop Loss: $8.50

Profit Target: $18.25

Timeframe: 8-10 months

Risk ($1.50) / Reward ($8.25) = 1 : 5,5 (very good ratio)

Position Sizing: Don't risk more than 1% of your equity

Investors should buy physical gold with both hands if prices move below $1,190 again. As well buy silver below $15,80. Buy both metals until you have at least 10% of your net-worth in physical gold and silver. But do not over expose yourself neither. 25% of your net worth should be the absolute maximum. If you want to be more aggressive put 2/3 into silver and 1/3 into gold.

5. Portfolio & Watchlist

6. Long-term personal beliefs (my bias)

Officially Gold is still in a bear market but the big picture has massively improved and the lows are very likely in. If Gold can take out $1,307 we finally have a new series of higher highs. If this bear is over a new bull-market should push Gold towards $1,500 within 1-3 years.My long-term price target for the DowJones/Gold-Ratio remains around 1:1 and 10:1 for the Gold/Silver-Ratio. A possible long-term price target for Gold remains around US$5,000 to US$8,900 per ounce within the next 5-8 years (depending on how much money will be printed...).Fundamentally, as soon as the current bear market is over, Gold should start the final 3rd phase of this long-term secular bull market. 1st stage saw the miners closing their hedge books, the 2nd stage continuously presented us news about institutions and central banks buying or repatriating gold. The coming 3rd and finally parabolic stage will end in the distribution to small inexperienced new traders & investors who will be subject to blind greed and frenzied panic.Bitcoin could become the "new money" for the digital 21st century. It is free market money but surely politicians and central bankers will thrive to regulate it soon.

- The Fed keeps pretending they can raise rates.- The market believes them until data tells another story.- How long will the markets keep falling for it?

Stop me if you've heard this one before: A Fed official walks into a bar and says the economy is improving and rate hikes are appropriate. The patrons order another round to celebrate. Then disappointing data comes out, the high fives stop, and the Fed official ducks out the back…only to come back the next day saying the same thing. Anyone who pays even the smallest attention to the financial media has experienced versions of this joke dozens of times. Yet every time the gag gets underway, we raise our glasses and expect the punch line to be different. But it never is. Last week was just the latest re-telling.For nearly a month the Fed's bullish statements stoked optimism on the economy and raised expectations, based particularly on the most recent FOMC minutes, for a summer rate hike. But these hopes were dashed by the May non-farm payroll report, which reported the creation of only 38,000 jobs in May, the worst monthly performance in six years, based on data from the Bureau of Labor Statistics (BLS). The number missed Wall Street's estimate by a staggering 120,000 jobs. If not for the 37,000 downward revision reported for April (160,000 jobs down to 123,000), May could have shown a contraction. This would have constituted a major black eye to the Obama Administration's favorite talking point that its policies have led to 75 months of continuous job gains. (6/3/16, Democratic Policy & Communications Center).To make the report even stranger, the plunge in hiring was accompanied by a drop in the unemployment rate to just 4.7%. Of course the fall in the unemployment rate was a function of another major drop in the labor force participation rate to just 62.6%, matching the June 2015 rate, which was the lowest level since the late 1970s (BLS). So the unemployment rate did not fall because the unemployed found jobs, but because they stopped looking. The market reaction was swift and sharp, as it always has been when a fresh shot of cold water has been thrown in the face of market boosters. The dollar fell hard and gold rose sharply.But we can rest assured that despite any embarrassment that the Fed may be experiencing for having so gloriously misdiagnosed the current economic health, it will be right back at it in a few days, telling us about all the positive economic signs that are emerging and how it is ready and willing to start raising interest rates at the earliest opportune moment. Boston Fed president Eric Rosengren waited exactly 48 hours to start that campaign as he sounded bullish notes in a Monday speech in Finland. (6/6/16, Greg Robb, MarketWatch)Given how many times this scenario has unfolded, leading to the point where even reliable Fed apologists like CNBC's Steve Liesman have begun questioning the Fed's credibility, one wonders what the Fed hopes to achieve by continuously walking into the bar with a new smile. But this performance is the only policy tool it has left. The Fed appears to believe that perception makes reality, so it will never stop trying to create the rosiest perception possible. It may view its own credibility as expendable.There is also the possibility, however unlikely, that the Fed officials are not just trying to create growth through open-mouth operations, but that they actually believe that their policies are working, or are about to work. This would be as dogged a commitment to policy as medieval doctors had for bloodletting, which they thought was a useful therapy for a variety of ailments. Doctors at that time had all kinds of seemingly plausible reasons why the technique was effective. If the patient did improve after draining blood, it was taken as a sign of validation. But they would continue to apply the leeches even if the patient did not improve. Failure was simply a sign that more blood needed to be drained. Similarly, central bankers consider ultra-low, and even negative, interest rates as an ambiguous stimulant that will create growth when applied in large enough doses.But what if modern central bankers, much like medieval doctors, are operating on a wrong set of assumptions? We know now that draining blood creates conditions that actually decrease a patient's ability to fight infection and recover. Perhaps, one day, bankers will come to a similarly delayed conclusion about how zero and negative interest rates have prevented a real recovery that would otherwise have naturally taken place.That's because artificially low interest rates send false signals to the economy, prevent savings and investment, and encourage reckless borrowing and needless spending. They prevent the type of business and capital investment that is needed to create real and lasting economic growth. But don't expect bankers, or their cheerleaders on Wall Street, the financial media, government, or academia, to ever make this admission. They do not believe in the power of free markets. They believe in government. Such a leap is simply beyond their powers of comprehension.But there is another cycle here that is much more influential on the current market dynamic and should be much easier to spot. When the Fed talks up the economy and promises rate increases, the dollar usually rallies. When the dollar rallies, U.S. multi-national corporate profits take a hit, and the market falls. When the market falls, economic confidence falls and puts pressure on the Fed to maintain easy policy. This is a loop that the Fed does not have the stomach to break.Because the Fed waited more than seven years to lift rates from zero, the cyclical "recovery" is already nearing its historical limit, if it's not already over. This could put the Fed into a position of raising rates into a weakening economy. Normally it does so when the economy is accelerating. Some identify this delay as the Fed's only policy error. But had it moved earlier, the recession would have simply arrived that much sooner. The Fed's actual policy error was thinking it could build a "recovery" on the twin supports of zero percent interest rates and QE, and then remove those props without toppling the "recovery."But despite all this, there are those who still believe that the Fed will deliver two more rate hikes this year. Given the anemic growth over the past two quarters, the recent plunges in both the manufacturing and service sectors, average monthly non-farm payroll gains of only 116,000 over the past three months (most low-wage, and part-time) and the stakes contained in the election that is just six months away, such a conclusion is hard to reach. Instead, I expect we will get the same bar gag we have been getting for the past year. Many of those who now concede that a June hike is off the table still believe July to be a possibility. I believe the Fed will go along with that hype until it can no longer get away with it…then it will start bluffing about September, or perhaps December.The Fed has to keep talking about rate hikes so it can pretend that its policies actually worked. But the truth is that the Fed policies have not only failed, they have made the problems they were trying to solve worse, and raising interest rates will prove it. So the Fed resorts to talking about rate hikes, to maintain the pretense that its policies worked, without actually raising them and proving the reverse. This can only continue as long as the markets let the Fed get away with it or until the numbers get so bad that the Fed has to admit that we have returned to recession. That is the point where the Fed's real problems begin.

- The precious metal has amassed 20 percent in the last six months.- Next six months may not prove so fruitful.- Technical indicators tell of lingering bearishness.

Precious metal gold has staged a remarkable comeback since December when it hit its nadir of $1,045. During the following five months, the rally extended more than 20 percent to head north of $1,300 albeit for a brief period. At the time of writing this analysis, Gold futures are trading at $1,247.

There are a couple of factors which convince me that the favorite investment during times of crisis is set to head significantly lower in the next 3-4 months. I have a downside target of $1,100.

First, let me put down the obvious ones. The U.S. Dollar has been fluctuating wildly as uncertainty grows over the fate of the interest rate hikes. With poor May jobs report, traders have [almost] completely ruled out a June hike, with most expecting the first hike in September, three months from now. This is not to suggest that I am trying to time the market, instead, it motivates me to remain cautious.

Another reason why gold, in my opinion, has been rising is because the investors see more risk in the stocks, so they are parking their funds in Aurum in order to hedge against the losses.

Add the Brexit uncertainty to the mix, and things turn highly favorable for gold.

Strong demand from importing nations such as India and China is also keeping gold afloat.

$1,050 proved highly irresistible, and looks like a strong medium-term support for the metal.

Global economic growth is faltering, to say the least. The monetary policies by the global central banks are failing at bringing economies back on the growth track, so diversifying into gold makes good investing sense.

But even with all these supportive factors, I feel that the precious metal might not add any significant gains from here on. Instead, gold is expected to lose sheen and tumble down to $1,100.

I am of the opinion that the Fed will raise rates at least twice this year, with the first one in July. As of now, the markets appear convinced that the era of low-rates will stay for longer, and therefore, gold remains buoyed.

My bearish stance is further substantiated by the current technical picture. The commodity is in the process of forming a bearish technical pattern called as the Head & Shoulders. The weekly gold futures price chart below clearly tells that $1,200 is the immediate floor i.e. the neckline of the pattern. A decisive breach of this neckline would accelerate losses, and we will see $1,100.

I have used three technical indicators for a stronger approval of my thesis.

Moving Average Convergence Divergence - This indicator states that the Histogram had already peaked out in February, and has been declining since then to dive into the negative territory. The MACD has crossed below the Signal Line - a bearish crossover - and warns investors of the coming decline.

Momentum - The Momentum indicator is a simple yet effective indicator. A reading above 0 suggests that bulls still have the game in their hands. Unfortunately for gold, the reading peaked out in March, and has dropped below 0 twice since April. The strong downtrend in Momentum suggests that the underlying support is weakening.

Money Flow Index - One of my favorite indicators, Money Flow Index is showing a strong divergence from the current price action. It hit its top when gold was trading at $1,287 and failed to register another high even when the price surpassed $1,300. Shockingly, the indicator has dropped below its previous bottom of 62, and is now at 53.2634. The fact that the MFI is consistently declining even in the face of rising prices is enough to convince me that now is the best time to go cautious.

Conclusion

Investors who are aggressively long on gold should reduce their exposure to a small amount.

This is what the charts are telling, and this is what I advise. But it would not be honest to not present a counter view to my thesis. In case my analysis goes wrong, the upside potential is capped at $1,400, which is roughly 12 percent higher from the present level.

The Chinese have a strategic problem in the South and East China seas. China is obviously interested in what happens in these waters. There is much speculation as to why the level of interest is so high.

The Chinese have a strategic problem in the South and East China seas. China is obviously interested in what happens in these waters. There is much speculation as to why the level of interest is so high.

The answer is simple: China wants to keep foreign powers away from its coast and away from waters vital to its global trade routes.

China’s greatest threat in these waters is the United States. Given the size of the US Navy and the location of the islands off China’s coast, the Navy is capable of blocking China's access to the ocean. This would deal a serious economic blow to China.

Countering this threat means building a navy that could challenge the US… a far from easy task. So, China’s actions in these seas are meant to intimidate regional countries away from American influence. The goal is to boost China’s ability to control shipping lanes. This calls for a show of strength.

Access to Trade Routes Tops Resources

Last week, US Secretary of Defense Ashton Carter gave a commencement speech at the US Naval Academy in Annapolis and focused heavily on the Chinese threat. He said:

China has taken some expansive and unprecedented actions in the South China Sea, pressing excessive maritime claims contrary to international law. Its construction—and subsequent militarization—of artificial islands on disputed features far surpass all other land reclamation efforts by other nations there, all other[s] combined. And when other aircraft, ships, and even fishermen act in accordance with international law near these features, China tries to some times to turn them away.

The Chinese shot back by charging Carter with having a Cold War mindset. Rhetoric aside, Carter’s comments stress the weight of ongoing events and merit a closer look.

There has been ample debate that China’s interest in the seas is linked to resources. Observers—notably those in the business sector—tend to believe that an economic motivation lurks behind every strategic move. Frequently, one does.

In this case, tapping oil that might be in the seabed would be very costly. In light of the current and foreseeable market for oil, this is not a viable plan. Moreover, oil platforms at sea are highly vulnerable to air attack. Extraction costs and exposure risk would render oil drilling irrational. So, let’s look elsewhere.

The real economic issue is that China’s coastal zone is hemmed in by large and small islands that stretch from the Strait of Malacca to Japan. These islands create fairly narrow passages, with many too shallow for deep draft vessels. The size of the US naval fleet means it could easily blockade China’s coast.

China wants to erase this threat. Its moves are designed to intimidate countries on the perimeter of these two seas, from Japan to Indonesia. The logical path to achieve this goal would be for its navy to take control of key islands blocking China’s access to the global oceans.

The problem is that China’s navy is not up to the task. There has been much talk about the surge of China’s naval power. However, this “surge” moves China’s capability from “very little” to “some.” China remains in no position to challenge the US, even in its coastal waters.

Threat Level of China’s Naval Power

The US Navy has an interest in presenting the Chinese as a serious threat.

Since the Cold War’s end, the US Navy has faced few challenges, and the fleet has shrunk in response. The growing Chinese threat supports the US Navy’s call to increase its budget. So, the Navy will estimate the potential threat to be as large as possible. This is the normal procedure for government bodies within the Congressional budgeting process.

The sense of dread about the Chinese navy stems from this dynamic. But the fact is, while China has built ships, it has not built a navy that is on par with the US.

The core American naval fighting force is the carrier battle group (CBG). The US has 11 such strike groups. The Chinese have yet to float a domestic-built, operational aircraft carrier, let alone a CBG.

China has ships: it does not have fleets. A fleet creates a single, integrated fighting force under a unified command.

Fleet operations—and having the ships fight an integrated battle—are very complex.

The key is to have experienced military leaders and well-trained staff. The needed experience is passed between generations of commanders, through tradition and doctrine. The Chinese have never had the sort of navy they are trying to build today. They can build ships, but creating an operational navy poses a big hurdle.

A Different Kind of Naval Threat

The Chinese have an alternative to a CBG and fleet operations: land- and air-launched anti-ship missiles. The Chinese might be unable to engage in surface-submarine warfare. They can, however, use missiles to force the US fleet away from crucial islands.

The Chinese have developed missiles with enough range to threaten a line extending from the Aleutian Islands to Guam to Australia. The strategy is to saturate US fleet anti-missile defenses using massive salvos of missiles. This would then clear the way for China’s navy.

This strategy has two flaws. First, this would require a space-based survey on the location of US ships across a broad area. A great deal has been made about Chinese anti-satellite capabilities. Yet, I strongly suspect the US—which has been refining this problem since the 1970s—is way ahead of China on this.

Second, China’s missiles are vulnerable. I would assume that US technical intelligence has mapped China’s launch sites and control facilities. The US would respond to the threat using air and missile attacks on Chinese launchers. This attack would not use nuclear weapons, but precision-guided munitions able to sufficiently diminish the Chinese threat thus allowing US fleet operations in the desired waters.

What’s Ahead for China

China is in a difficult military position. Its best strategy is to convince countries like the Philippines that they are better off aligning with China than the US. To do this, it has made fairly feeble moves around key islands, dredging sand to make new islands, moving ships around, and flying close to American aircraft.

None of these tactics are strong enough to change the balance of power in the waters around China. Ironically, they have drawn an increased American presence. China can make threatening gestures toward the US but can’t afford to mount a serious challenge.

The precise capability of the Chinese navy is an open debate. But to engage the US in combat and suffer defeat—even in a small skirmish—would be among the worst outcomes for China.

China’s strategy of inducing shifts in the alignment of countries around the South and East China seas requires a credible naval force. But China cannot predict how capable its navy will be in combat.

The political fallout from failure would cascade globally, regionally, and within China. China is currently trying to hold things together in the face of domestic economic failures. Its emergence as a global power acts as a psychological brace for the regime. It cannot afford to lose that brace.

This explains why the Chinese can’t let go of the two seas issue, nor can they do anything decisive. Carter’s description of what is going on is fairly reasonable. But it does not amount to a serious military threat.

China’s various minor actions have been magnified by the Chinese and the Americans for different reasons. Still, the fact is that China has been very cautious in a matter of fundamental importance to it: access to the world’s oceans. If it could have done something decisive, it would have. The risks and the realities at sea being what they are, China is likely to continue this strategy.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.